Market View - June 2010

As turmoil continued to bedevil global equity, debt and currency exchanges during May, investors could be forgiven for asking whether they would be better advised to simply put their money under the mattress and save themselves and their advisers all the stress of the rollercoaster that has come to symbolize the modern day market!

Just a couple of short months ago, in our commentary we confirmed how rosy everything appeared in the garden with the US equity market as measured by the S&P 500 up 6% in March alone and more than 75% in less than a year at that point, but now in May we see all the gains from March and April more than wiped out with an 8% reversal over the month! The FTSE 100 did not fare much better falling 6.57% over the month, while the Emerging Markets index fell more than 9% and the Japanese Nikkei did worst of all falling 11.65%.

The increased volatility was caused by a number of factors including rising geopolitical tensions between the West and North Korea, the ongoing contagion from the Euro area government debt crisis, and increasing concerns about a double dip recession based upon anaemic growth in the US now that the massive stimulus packages are drying up, and further evidence suggesting the Chinese property bubble (if there is one) could be about to burst. This last concern has impacted adversely upon some commodities such as copper as well as related mining companies in particular since such a large amount of this sector is dependent upon Chinese growth continuing to shore up demand.

The front page of a recent edition of The Economist summed it up perfectly with a picture of a shark's fin just above the water line and written above it "Fear returns", while their leader article's sub title read "Governments were the solution to the economic crisis. Now they are the problem" The Economist article does go on to suggest that the market's concern is almost certainly overdone but is in the short term reflecting the very grave danger to markets if governments get it wrong, especially in Europe where "for the euro to survive, Europeans need to be prepared not just for painful fiscal adjustment but for profound structural reform as well".

Britain's new government has thus far shown some encouraging initiatives on how it will tackle the fiscal deficit, but we must wait until the forthcoming budget later in June to find out whether they can skilfully administer the requisite cuts without triggering another recession. Meanwhile paradoxically America has benefited from the Greek crisis through reduced bond yields, even though its structural budget deficit will soon be bigger than that of any other OECD member.

As the Economist leader article quotes "the country badly needs a plan to deal with its fiscal deficit, but for now lower bond yields and a stronger dollar are the route through which American spending will rise to counter European austerity". This may be just as well since during the next six weeks alone the US has $673 Billion in commercial bond paper that will need to be refinanced.

Coming back to our opening comment, and the under the bed investment option, another excellent article in a recent issue of The Economist titled "The deflation dilemma" sums up perfectly why only through investing in real assets can most investors expect to preserve and hopefully increase their savings. According to a poll taken by The Economist of more than 50 leading global economists, deflation is the greater threat over the short term in richer countries, while inflation is perceived to be the main concern in emerging economies, but also expected longer term to become so in the richer world!

The consensus is also that deflation is much a much more difficult problem to deal with than inflation, and certainly Japan's experience of the past two decades would appear to support this. For this reason the central banks of the US, Europe and the UK could very well keep interest rates low for several years to come, albeit this combined with continued quantitative easing programmes could eventually result in severe longer term inflation, and almost certainly more asset bubbles in emerging economies which are likely to be the beneficiaries of hot cash flows seeking higher yields and returns.

With various real asset investment options likely to remain volatile for some time, we believe it will pay as always to pursue an active risk controlled asset allocation strategy!